Download The Platinum Japan Fund Limited

The Platinum Japan Fund Limited
Quarterly Report
30 June 1999
Performance
The Japanese stock market continued to move ahead strongly with the
benchmark Nikkei index rising by 7% (in yen terms) during the quarter. However,
in contrast to the previous quarter the advance was concentrated more in the
secular growth areas of telecoms, high technology and consumer lending rather
than the cyclical areas such as banks and construction which saw declines.
Small stocks (the OTC market) were also strong rising by 42%. The fund was
well positioned in these areas with the likes of NTT DoCoMo, DDI, Fujitsu and
Shinkawa all rising by more than 25%. In addition, the Korean holdings
performed very well on the back of a reviving economy. The consequence of this
was a rise of 17% in $US terms in the portfolio versus 6% for the index.
Commentary
The surprising development was the reporting of 7.9% annualised GDP growth for
the March quarter. Whilst not really believable in terms of its magnitude, it did
however combine with other data suggesting some stabilisation in the economy to
challenge many investors’ notion that Japan is a country in terminal decline. In
addition, the Bank of Japan reiterated its zero interest rate policy and aggressively
intervened in the currency markets to the tune of $US22 billion ostensibly to
prevent currency appreciation heading off the fledgling recovery. Together, these
two events reinforce our belief that we are in the very early stages of an economic
up-cycle. It is likely to remain patchy for some time as corporates restructure and
unemployment grows. However ,we believe there is an inevitability about it given
the improvement being seen in neighbouring countries and on account of
overnight money earning zero return.
As noted previously, it is the corporate sector that will lead change in Japan. This
will come in the form of a greater awareness of the need for profits and a
reassessment of the imbalance of the labour/capital profit share in the economy
as firms restructure. Further, we believe that many of the government agencies
have lost credibility in the eyes of the public and this has diminished their
influence in political circles. Initiatives have however been proposed which will
help corporations restructure their businesses with the aid of tax breaks. At the
same time, job creation schemes are being dreamed up by the bureaucrats with
banner headlines proclaiming the magnitude of these proposals. To some extent
we regard these as a confidence boosting exercise.
The quarter saw a continued flood of restructuring announcements which
included paring of workforces, linking of pay rates to performance and joint
venturing of loss making businesses. We highlight the linking of Hitachi and NEC
in the joint development of memory chips as highly significant in that it reduces
costs and leads to consolidation of market share. It would not have been long
ago where an alliance of such magnitude between these fierce competitors would
have been taboo but such have been the pressures for change that the walls are
starting to break down. From our visits to Japan, it is clear that many more things
are being talked about behind closed doors. Another interesting development
was that of British Telecom and AT&T buying into Japan Telecom, the third
largest operator in Japan. This highlights the impact of globalisation on the
behaviour of corporations within Japan. We would expect to see many more
deals like this and expect that it also has the positive side effect of imposing much
more discipline on corporate returns than has been the case.
Having seen about 25 companies in the seven days we have just spent in Japan,
we kept being reminded of the technical competence that pervades this country.
At every level there is a commitment to the improvement of processes and the
development of innovative products. Throughout this post-bubble period
companies have continued to deepen their technical competence with some of
the largest research and development budgets in the world. Japan is ideally
situated in this digital age which calls for expertise in the areas of optics,
miniaturisation, micro-chip design and production. For those sceptics who believe
that the Japanese have poor chip design and software skills, we suggest they
examine the products being developed by the likes of Sony and Nintendo and
several game software houses. Not only are these products world beating, but
the power and speed of the logic and graphic chips are quite as interesting as
anything coming out of Silicon Valley. The visit to Matsushita (which is the largest
supplier of consumer electronic goods in the world and the owner of the National
Panasonic brand), was particularly memorable. While conceding they had paid
too little attention to profitability in the past, they exuded a calm and deliberate
confidence in their technical prowess which they believe is unmatched in their
field. A product they are particularly proud of is their achievement of condensing
the principal workings of a digital TV receiver onto a single chip.
Our major theme in Japan remains information technology which we broadly
define as telecommunications, computer hardware, semiconductors and
software. Japanese companies are typically well behind their international
counterparts in terms of their systems to manage information flow. This shows
up most starkly in rates of PC penetration, internet usage and adoption of
package software solutions such as SAP. The reality is that pressures from
globalisation and changes in issues such as accounting standards will require
much greater standardisation of effort. The opportunity is that people are
conditioned by the past history of sales and risk underestimating the spending
that will be unleashed as corporate profits improve. Already PC shipments have
started to grow at 50% pa and this will be just the beginning as these machines
are linked into networks and the internet.
Breakdown of Portfolio
Categories
Cyclical Growth
High Growth
Deep Value Cyclicals
Steady Growth
Market Levered
Korea
Cash
Examples of
Stocks
Sony, Kyocera, Fuji Photo Film,
Canon
Mobile Telecoms – DDI,
DoCoMo
Outsourcing – Trans Cosmos
National House, Taikisha,
Rinnai
Coca Cola Bottlers,
Pharmaceutical Companies
Daiwa Securities, Nikko
Securities
Korea Telecom, Lotte
Confectionery
Holding
23%
20%
12%
10%
8%
19%
9%
Outlook
Clearly with such a strong performance in our inaugural year, investors will ask
where do we go from here? Our view is that we are in the early stages of a multiyear bull market which will be driven by a rising share of corporate profits of GDP.
We think that it will unfold something like this:
Bottom – The economy seems like it will never recover. The Bank of Japan
moves to zero interest rates but locals run scared. People dismiss the reality of
the impact of restructuring on corporate profits and look only at the behaviour of
consumers in aggregate.
Early realisation – The economy shows no signs of life but corporations act
independently to cut costs and restore profits (helped by government tax
reforms). Restructuring announcements and merger and acquisition activity
gains momentum. The market moves up with sporadic bursts, climbing a wall of
worry.
Dawning of reality – Corporate profits start to lift and the economy shows some
small signs of life. Participation by individual investors broaden from the initial
broker margin players. Institutions start to fret about their low weightings in
shares versus bonds (which by now are looking more dangerous as yields creep
up).
Reality – Locals start to act on their new found confidence and buy the market.
Land prices start to move as the wealth effect kicks in.
Hyper reality – Newspapers start eulogising about the new Japan economic
growth machine and carry stories about the new rich - individuals who setup their
own business and have made good.
We believe we are still in the early realisation stage with local institutions still very
wary (and tending to sell shares into strength) and the market is being carried by
foreigners and some brave private investors. There will be setbacks as markets
typically run ahead of the reality and perhaps external events come to the fore but
as the process gathers momentum, the market should become more robust and
move considerably higher on a three year view. In simple terms, the index at
18,000 is still only 50% of its previous peak made some nine years ago! Just as
importantly, when we look at the stocks we own, whilst some have run hard, on a
three year view all of them still offer considerable share price appreciation and
once again our problem is choosing from the smorgasbord of opportunities.
Lastly, ownership of Japan by foreign private investors is still tiny and one can
imagine how foreign buying pressure can build.
US Mutual Funds – categorised by regional funds in US$ billion.
International Equity
European
Emerging Markets
Asia ex Japan
Japan
$229
$42
$27
$10
$3
Note. International funds are barely at index weight and the Japanese economy
is much larger than all the emerging markets, including Asia.